Longer Term CFD Trading – Why it is Possible
CFDs are not normally associated with long term trading. Most traders use them for short term speculative trades on shares, commodities or currencies. This simply means that many traders are missing out on lucrative trades which can bring in substantial rewards over a period of a few weeks or even months.
Trading CFDs over a longer period of time is known as position trading. The trader would typically use both fundamental analysis and technical analysis to identify a trend or anomaly in the price of a particular asset before opening a position.
Position trader is not that different from what is known as ‘buy and hold’ in the world of investing. The major difference lies in the fact that CFDs are leveraged. Even a small adverse move could mean a significant loss to a trading account, but of course a small move in the right direction could also mean big profits.
This is why the correct use of stop losses is vitally important with position trading. Setting them too tight would cause numerous small losses, which could wipe out the profits from even a large price movement in the favoured direction. Using the average true range to help determine the stop loss is recommended.
The use of limit orders to exit a profitable trade could work against a trader with position trading. While it could lock in a temporary profit, it will also more often than not lock the trader out of really big price moves in the favoured direction.
Financing charges play an important role with position trading. With a leveraged trading instrument such as a CFD the broker is in fact financing a large part of the trade and hence the trader has to pay finance charges on this amount. While this might not be significant in day trading, it can gradually erode the profitability of a long-term trade. Take into account that the higher the leverage of the CFDs, the higher the finance charges will be.
Identifying a suitable trend
Position trading is virtually synonymous with trend trading. While spotting a trend developing is usually not very difficult, using a suitable technical indicator will be very useful. The Japanese Ichimoku Kinko Hyo is an excellent tool for this job. Fig. 10.26(a) shows a chart of the AUD/USD where the Ichimoku clearly indicated the start of an uptrend at point A.
This trend ended up lasting close to a year and took the AUD from about 0.86 against the USD right up to 1.10. The lucky CFD position trader who went long at point A would have made a small fortune in the process.
A lot of the eventual success of the trade will depend on correctly timing one’s entry. While using the Ichimoku Kinko Hyo would have worked great in the above example, this will not always be the case. To eliminate false breakouts, the trader should not rely on a single indicator to time his or her entry.
A great option is to use fundamental analysis for the initial trade selection and then to employ a technical indicator such as the Ichimoku Kinko Hyo to time the exact moment of entry.
This is what really requires nerves of steel. Exiting a profitable position too early could mean missing out on a major part of a trend. In Fig. 10.26(b) below, a trader who exited the trade at point B, when the price of the AUD dropped back into the Ichimoku cloud, could have lost out on nearly 50% of the total trend. This is when confirming the exit level with either fundamental analysis or a second indicator could be very useful.